The Expected “One Day Outlier” Occurred Last Thursday

The Expected “One Day Outlier” Occurred Last Thursday

Posted on September 29, 2014

Canterbury Portfolio Thermostat-Weekly Update- 9/29/14

Market State 2 (56 trading days) - Long-term: Bullish; Short-term: Neutral/Bullish.  

Canterbury Volatility Index (CVI) is at CVI = 47 - (Bullish): A week ago Friday (9/19/14) volatility, as measured by the CVI, tied the lowest level seen since the first quarter 2007, at CVI 40. There was no change in any of the CVI volatility indicators. Therefore, the Major markets remain in a rational and Bullish environment.  

Last week’s update also stated: “The important point to remember is that such moves are just part of the random market noise and will have little impact on the overall trend. Daily declines on the Dow, in the 100 to 190 range, do not count as “one day outliers”, but as normal market noise.

The Weekly Update warned that extremely low levels of volatility, such as the low level we have been experiencing, can result in a “one day outlier.” For example, when a financial market or security becomes too complacent and the Canterbury Volatility Index (CVI) reaches an extremely low level, then the probabilities of an isolated one day decline in the -1.5% to -2.0% ranges becomes likely.

 

An extended period of extremely low volatility is similar to squeezing a spring between your thumb and forefinger. The tighter it is squeezed, the bigger the pop when it is let go. This is exactly what occurred last Thursday when the S&P 500 dropped -1.62% and the Dow declined 264 points or -1.54%. 

Overbought/Oversold "Oscillator” is currently 89% oversold (Bullish/Neutral): This is a leading indicator that will often give an early indication that the market is near a short term bottom. The recent sell off has created a short term oversold condition. 

The Dow and S&P 500 continue to overstate the strength of the broader market. The following is an overview of several popular indexes for the month of September and quarter to date:

Index                                        September to Date           3rd Quarter to Date S&P 500                                            -0.89%                               +1.66% Dow Jones Industrials                     +0.17%                                +2.29% MSCI World All Cap.                      -3.01%                                 -2.58% MSCI Emerging Markets                 -5.71%                                -1.73% Russell 2000                                     -4.55%                                -5.88% NASDAQ 100                                  -1.43%                                +2.64%     US Treasury - 20 yr.                         -2.15%                               +2.80% Gold (GLD)                                      -5.49%                                -8.58% US Dollar (UUP)                              +3.54%                              +7.24%

Source: Orion Advisors

Comments:  

                                                                                                                                                       

The Dow, S&P 500 and NASDAQ 100 remain in Bull markets. It is important to understand that a Bull market is more about the predictability of risk than it is about the predictability of return. In other words, a primary characteristic of a Bull Market is stability and low volatility. 

Bull markets are efficient and the risk is typically predictable. A definition of a normal Bull market “pullback” is about a -5% decline from the peak value. A Bull market correction is in the -10% range, from the previous peak. A -5% or -10% correction falls within the normal expectations and is a sign of a healthy market environment. 

On the other hand, the expected return during a Bull market is much more difficult to predict. A Bull market has very clear markers or characteristics, as do Bear Markets. A Bull market can produce a wide range of returns over varying time periods. Bull markets can cover long or short periods. Some Bulls will end following a parabolic advance while others will remain in a trading range for long periods and go nowhere. 

The Portfolio Thermostat’s indicators can identify the most desirable Bull market markers that have a high probability of going up with limited risk. In terms of knowing if the selected securities will remain the top leaders, only time will tell. A market index, portfolio or a security, that has the same Bull market characteristics in place, will generally have a return dispersion in the 5% or 10% ranges for up to a year or so.

 

The following is an example of randomness among returns for two market indexes with similar Bull market characteristics: 

PERIOD 1 - First 6 months of 2006                PERIOD 2 First six months of 2014

Highest Volatility for period: CVI = 68          Highest Volatility for period CVI = 66

Lowest Volatility for Period: CVI = 39           Lowest Volatility for Period: CVI = 39


RETURNS - First 6 months of 2006               RETURNS: First six months of 2014

Dow Jones Industrials:          10.93%            Dow Jones Industrials:        3.13%

S&P 500:                                     2.71%        S&P 500:                         7.57%

The volatility ranges for Period 1 and Period 2 were very similar but the returns between the Dow and S&P 500 varied widely based in noise and randomness.

Bottom Line:      

   

Bull markets tend to have low risk but variable ranges of returns between similar indexes. A successful portfolio should adapt to the existing market environment for the purpose of participating on major market moves and avoiding or benefiting from Bear stock market declines.  Bull market environments, marked by low volatility, are not the periods that long term investors need to worry about.

                                             
Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), makes all the final decisions on all investment and portfolio management decisions for Canterbury Investment Management. Tom has more than 30 years experience in the investment management industry and has broad breadth of knowledge. He is known as an innovator, educator and been revolutionary in the advancements in portfolio and risk management.

Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.